BIZ ORG OUTLINEAGENCYWHO IS AN AGENT A. Agency is the fiduciary relation which results from i. Consent a. Consent by the principle for the agent to act, must manifest that the agent will act for him ii. Acceptance a. Agent must accept the undertaking, act on behalf of the principle (& both parties intend this) iii. Control 1. Understanding that the agent is subject to control by the principle. (a) Control only over the goal, not the means of accomplishing it (lawyers). B. Formation & termination of an agency relationship i. Unlike a contract (which is negotiated etc.) an agency agreement is created very easily. Once A agrees to do something for P, and A is acting on Ps behalf & is subject to Ps control the agency relationship is created. a. Gorton v. Doty, 69 P.2d 136 (1937) woman tells the football coach who needs to transport students to a game to use her car (but only he can drive it). She volunteered the use of her car, no compensation. Accident happens & suit against the woman, as the principle. Agency relationship existed here between woman & coach. Woman consented that coach act in her behalf in driving her car by volunteering her car & her condition that only he drive it shows the control she had. 1. How you describe it makes the diff on whether or not its agency: (a) Gave permission this is a loan, not agency (b) Directed - telling him what to do this is agency. 2. This is a little extreme b/c it almost looks like it was only a loan. But fact is that insurance is covering the woman, and the boy injured has no insurance. So looks like court just wanted to cover the boy. 3. Solution: if she had specified she is loaning the car to him, then that would have settled it. b. It is not essential that there be a contract between the principle and agent or that the agent promise to act as such, nor is it essential to the relationship of principle and agent that they, or either, receive compensation. ii. Agency can be terminated at the will of either party (notion that involuntary servitude is bad). Different from contract relationship which you cannot just breach & court will enforce. C. Creditor-debtor relationship vs. agent-principal relationship i. A creditor who assumes control of his debtor's business may become liable as principal for the acts of the debtor in connection with the business ii. Gay Jenson Farms Co. v. Cargill, Inc., P. 7 Court found agency relationship due to the amount of control exerted by Cargill on Warren 1

1. Consent by principle C consented by directing W to implement certain procedures 2. Agent acting on behalf of principle W acted on Cs behalf in procuring grain for C, as part of its normal operation which were totally financed by C. 3. Principle exercise control over agent - C had a lot of influence and control over Ws financial situation. b. An agreement may result in the creation of an agency even though parties didnt call it an agency and did not intend the legal consequences of the relation to follow. c. Someone who contracts to acquire something from a 3rd person and convey it to another is an agent only if it is agreed that he is to act primarily for the benefit of the other. AGENCY POWER TO BIND - LIABILITY OF PRINCIPLE TO THIRD PARTIES IN CONTRACT y y Actual Authority - principle gave the agent the authority explicitly; completely clear Implied Authority - Implied authority is actual authority circumstantially proven which the principal actually intended the agent to possess and includes such powers as are practically necessary to carry out the duties actually delegated. o To determine whether implied authority exists, it must be determined whether the agent reasonably believes because of present or past conduct of the principal that principal wishes him to act in a certain way or have certain authority. Sometimes may be necessary to implement express authority Prior similar conduct o i.e. Have authority because its something that normally goes along with the actual authority given. Mill Street Church of Christ v. Hogan, 785 S.W.2d 263 (1990) Church has hired y Bill to paint. B hires S to help, S is hurt and wants workers comp, but only for employees. Did B have authority to hire S? a. Bill is an agent of the Church (an employee Church hires Bill & has control over Bill) b. Bill didnt have actual authority to hire Sam, but had implied authority. 1. past conduct - Bill had been allowed to hire Sam for previous work. 2. necessary to implement the express authority - in order to finish the work, Bill had to hire a helper. 3. agent reasonably believed he had the authority - practice in the past; Bill never told otherwise; Church even paid Sam for hours worked. D. Apparent Authority when a principle acts in such a manner as to give the impression to a third party that the agent has certain powers which he may or may not actually possess. It is a matter of appearances on which third parties come to rely. i. 3rd parties have the right to believe the agent has the authority it is reasonable to believe they have. ii. Three-Seventy Leasing Corporation v. Ampex Corporation, 528 F.2d 993 (1976) Joyce, the only employee of 370 corp, is in negotiations to buy HW from Ampex & 2

is speaking to Ampexs employee, Kays (salesperson). Kays sends Joyce an offer at the direction of Kays superior. a. An agent has apparent authority sufficient to bind the principal when the principal acts in such a manner as would lead a reasonably prudent person to suppose that the agent had the authority he purports to exercise. b. Absent knowledge on the part of 3rd parties to the contrary, an agent has the apparent authority to do those things which are usual and proper to the conduct of the business which he is employed to conduct. c. Kays was employed by Ampex as a salesman; it is reasonable for 3rd parties to presume that a salesman has the authority to bind the employer to sell. d. Ampex's actions furthered this belief; Document was given to Joyce at the direction of Mueller, Kay's superior, and also Mueller agreed that all communication with 370 would be through Kays. Doesnt matter if, internally, Kays really didnt have this power. E. Inherent Agency Power authority that comes from the role/status that comes with being an agent. The agent (in the role/status) ordinarily possesses certain powers. i. A servant acting within the scope of his employment has inherent authority to commit torts - basically same thing as respondeat superior. ii. Watteau v. Fenwick, Queen's Bench (1892) - Humble sold business to Fenwick, but Humble still manager, and Humble name on the door. Humble buys a bunch of stuff, no payment a. Rest (2nd) Agency 194 - an undisclosed principle is liable for acts of an agent done on his account, if usual or necessary in such transactions, although forbidden by the principle. b. Rest (2nd) Agency 195 - an undisclosed principal who entrusts an agent with the management of his business is subject to liability to third person with whom the agent enters into transactions usual in such business and on the principals account, although contrary to the directions of the principal. c. J. Learned Hand - "It makes no difference that the agent may be disregarding his principal's direction, secret or otherwise, so long as he continues in that larger field measured by the general scope of the business entrusted to his case." d. Rest (2nd) Agency 161. A general agent for a disclosed or partially disclosed principal subjects his principal to liability for acts done on [the principles behalf] which usually accompany or are incidental to transactions which the agent is authorized to conduct if, although they are forbidden by the principal, the other party reasonably believes that the agent is authorized to do them and has no notice that he is not so authorized.

LIABILITY OF PRINCIPAL TO THIRD PARTIES IN TORT I. Roseburg says three factors: A. Time/place B. Hired to do C. Scope of employment (see below)3

II. Servant v. Independent ContractorA. A master is subject to liability for the torts of his servants committed while acting in the scope of their employment. As a general rule, a principle is not liable for the torts of his non-servant agents - i.e., independent contractors. i. Servant-Master Relationship respondeat superior; master liable for torts of his servants a. Master/servant relationship exists where the servant has agreed to work on behalf of the master and to be subject to the master's control or right to control the "physical conduct" of the servant (the manner in which the job is performed as opposed to the result alone). ii. Independent contractors a. Agent-type independent contractor - one who has agreed to act on behalf of another, the principal, but not subject to the principal's control over how the result is accomplished (over the physical conduct of the task). b. Non-agent independent contractor - one who operates independently and simply enters into arm's length transactions with others B. Whether the relationship between the parties is an agency relationship does not depend on what the parties call it, but what it actually is. The parties cannot effectively disclaim it by formal consent. i. Humble Oil & Refining Co. v. Martin, 222 S.W.2d 995 (1949) Love gives her car to gas station owned by Humble for servicing. Negligence by gas station & Martin injured by the car. Humble liable for negligence? Humble says no b/c gas station operated as an independent contractor, Schneider. Neither Humble nor Schneider considered Humble the employer. a. Court says its a servant-master relationship, so Humble is liable. Humble had strict financial control & supervision over the gas station. 1. Humble furnished the station location, equipment, advertising, and a substantial part of the operating cost (they gave a 75% commission on Schneider's payment of utilities, so Humble was effectively paying 75% of the utilities). Hours of operation controlled by Humble. Humble could terminate at will Schneider's occupation of the premises. Schneider had to do whatever Humble told them to do. The only thing Schneider had the discretion to do was hiring, firing, payment and supervision of the few employees. So looks more like Schneider is an employee just being paid based on commission. C. Control is an essential element of an agency relationship, whether a servant or an independent contractor. To determine whether the relationship is master-servant, the court will look at whether the principle had control over the day-to-day operations. i. Hoover v. Sun Oil Company, 212 A.2d 214 (1965) gas station employee negligently caused a fire at a service station owned by Barone. s brought suit against Sun Oil, Barone & the employee. Barone leased the gas station from Sun, & had a dealers agreement that dictated the K between them. Barone not obligated to do what Sun would recommend, & determined the day-to-day operations. Barone could sell whatever he wanted, although there were rules on what he used Suns products for. 4

a. Held independent contractor - the close contact between the two show merely that they have a mutual interest in the sale of Sun products and in the success of Barone's business. Sun did not have control over the day-to-day operations. 1. Control or influence over the results alone is insufficient. D. Franchise agreement - the franchisee will agree to operate its business in certain ways, as required by the franchisor, in exchange for the use of the license. The purpose of this is to create standardization in all the franchises nationwide (to achieve the "brand"). However, a franchise could still be a servant-master relationship if there is sufficient control by the franchisor. i. Murphy v. Holiday Inns, Inc., 219 S.E.2d 874 (1975) - Betsey-Len Motor Hotel Corporation had a licensing agreement (franchise) with Holiday Inns, to use their name/logo. Architecture of Betsey must be approved by Holidays Inn, Betsey not allowed to sell stock w/o approval, Betsey must operate under Holidays rules of operation & make quarterly reports & submit to periodic inspections by Holiday. A customer had a slip & fall and sues Holiday Inn for the negligence. a. Not servant-master, this is a typical franchise agreement. Holiday Inn does not have the control or right to control the methods or details of doing the work. The purpose of the provisions was to "achieve a system-wide standardization of business identity, uniformity of commercial services . for the benefit of both contracting parties." Betsey still had the control over the day-to-day operations, and most other powers customarily exercised by an owner. ii. Rationale for allowing a certain level of control in franchising agreements: a. The problem of free-riding: franchisee would take advantage of other peoples investments (establishment of the brand name) and exploit it. If the franchisee could do whatever they wanted, it would ruin the brand name.

III. Tort Liability and Apparent AgencyA. Advantages of setting up a business as a franchise: i. Establish a brand name ppl can walk in any location and know what to expect ii. Less liability for the national company than having branches a. But national wants some control since theyre promising something iii. Owners will work harder than managers, even though same money & same job B. Policy Issue for franchises should we allow businesses to insist that they present themselves as one enterprise for purpose of advertising, but then turn around for tort purposes and say were 2 enterprises? On its face it looks like consumer fraud. Although its ok for contract purposes, not clear if its ok for tort purposes. C. Miller v. McDonald's Corp., 945 P.2d 1107 (1997) - sues McDonalds for injuries b/c she bit into a stone while eating a burger. McDonalds was a franchise, owned by 3K, & had an operating agreement that required 3K to operate in a manner consistent with the McDonalds system, and described how it should be operated in a lot of detail. K also explicitly stated 3K not an agent for any purposes. i. Liability under Actual Agency: The Control Test If the franchise agreement goes beyond the stage of setting standards, and gives the franchisor the right to exercise control over the daily operations of the franchise, an agency relationship exists. a. If McDonalds retained sufficient control over 3K's daily operations, then an actual agency relationship would exist (jury question). Agreement didnt just set 5

standards - it required 3K to use the precise methods that McDonalds established. McDonalds enforced the use of those methods by regular inspections & retained power to cancel the Agreement. ii. Apparent Agency - One who represents that another is his servant or other agent and thereby causes a third person justifiably to rely upon the care or skill of such apparent agent is subject to liability to the third person for hard caused by the lack of care or skill of the one appearing to be a servant or other agent as if he were such. a. Question for jury whether McDonalds held 3K out to be its agent & whether justifiably relied on that representation 1. (Representation) Everything about the appearance of the restaurant identified it with McDonald's - this image the McDonalds had worked to create reputation, etc. 2. (Reliance) General public not expected to understand how franchise works. McDonalds cannot ignore its own efforts to lead the public to believe that all McDonald's are the same.

IV. Scope of EmploymentA. Conduct of a servant is within the scope of employment if it is actuated, at least in part, by a purpose to serve the master (this is the minority, majority, must be in furtherance of masters objective.) see below i. Ira S. Bushey & Sons, Inc. v. United States, 398 F.2d 167 (1968) - Sailor (works for U.S.) arrived back at his ship drunk, and negligently caused damaged to the ship & drydock (owned by ). U.S. argues its not liable b/c sailor acting outside scope of employment. a. The sailor's conduct was not so unforeseeable as to make it unfair to hold the government liable. The employer should be held to expect risks, to the public also, which arise 'out of and in the course of' his employment of labor. It is foreseeable that a drunken sailor might cause damage while crossing a drydock on the way back to his ship. B. Rosenberg: Three ways to determine scope of employment i. Motive, why did the person do what they did? ii. Public policy approach iii. Bushey standard (above, no requirement of purpose to serve the master as the restatement does, just foreseeablility) C. A servant's acts may be within the scope of employment although consciously criminal or tortious (except serious crimes). A servant's use of force against another is within the scope of employment if the use of force is may be expected by the master. i. Ex: the owner of a nightclub probably would be held liable for injuries inflicted by a bouncer in ejecting someone from the bar. The owner presumably hired the bounder for the very purpose of using force to eject drunken or otherwise undesirable patrons. ii. Manning v. Grimsley, 643 F.2d 20 (1981) professional baseball game, pitcher threw a ball at & injured him ( heckling him, and evidence that pitcher did it intentionally). Court found employer liable for pitchers action b/c he was acting within the scope of his employment. 6

a. To recover damages from an employer for injuries resulting from an employee's assault, it must be shown that the assault was in response to the 's conduct which was presently interfering with the employee's ability to perform his duties successfully. 1. The heckling was conduct that had affirmative purpose to interfere with employees performing his duties successfully, and the pitcher's assault was not a mere retaliation for past annoyance, but a response to continuing conduct which was presently interfering with his ability to pitch in the game.

V. Liability for Torts of Independent ContractorsA. Ordinarily when a person engages an independent contractor (who conducts an independent business by means of his own employees), he is not liable for the negligent acts of the contractor in the performance of the contract, but there are three exceptions: i. When landowner retains control of the manner & means of the work contracted for ii. Where he engages an incompetent contractor iii. Where the activity contracted for constitutes a nuisance per se. a. Liability imposed upon a landowner who engages an independent contractor to do work which is inherently dangerous (a nuisance per se). 1. Inherently dangerous - an activity which can be carried on safely only by the exercise of special skill and care, and which involves grave risk of danger to persons or property is negligently done. 2. Ultra-hazardous - an activity which necessarily involves a serious risk of harm to the person, land or chattels of others which cannot be eliminated by the exercise of the utmost care, and is not a matter of common usage. Liability is absolute where the work is ultra-hazardous. b. Majestic Realty Associates, Inc. v. Toti Contracting Co., 153 A.2d 321 (1959) Authority hires Toti to demolish a building which was adjacent to 's. In the process, there was damage to 's building. Evidence showed that it was hazardous work. Authority held liable b/c the work was inherently dangerous.

FIDUCIARY OBLIGATIONS OF AGENTS VI. Duties during AgencyA. Reading v. Regem, 2 KB 268 (1948) - sergeant in the British army paid a lot of money by escorting a smuggler's trucks. Crown gets the money i. Servant is liable to his master if he takes advantage of his service and violates his duty of honesty & good faith to make a profit for himself, and the position he occupies is the cause of obtaining the money, rather than providing the opportunity for him to get it. Doesnt matter if master hasnt lost any profit or sustained any damage, or that master couldnt have done the act himself. ii. Examples: a. Money goes to master - Police officer accepts bribes to direct traffic away from crime scene. The only reason he had any authority to be able to direct traffic away & the only reason he got paid, was b/c of his position as a police officer & his uniform.

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b. Servant keeps the money - Employee during time he's supposed to work, gambles. Employer can sue him for breach of K, but the money he makes from the gambling is his. B. Agent has the fiduciary duty to act solely for the benefit of the principle. An employee violates this duty by failing to disclose all facts relating to his work and by receiving secret profits from it. i. General Automotive Manufacturing Co. v. Singer, 120 N.W.2d 659 (1963) Singer worked for General. Employment K says Singer would devote his entire time, skill, labor and attention to said employment and not to engage in any other business. Singer doesnt think General can fill some orders & gets them filled somewhere else, making himself a profit. a. Singer violated his fiduciary duty to act solely for the benefit of General, so he is liable for the amount of the profits he earned in his side business. He had a good faith duty to disclose the fact that he didnt think General could fill the orders; then General could decide what to do. VII. Duties during and after termination of Agency (see below for more grabbing and leaving) A. Post-termination competition with a former principle is permitted, but the former agent is barred from disclosure of trade secrets or other confidential information obtained during his employment. B. Soliciting former employers clients i. Town & Country House & Home Service, Inc. v. Newbery, 3 N.Y.2d 554 (1958) was an employee of , a house cleaning service. leaves employment, then sets up a competitive business. had breached the confidential relationship (b/c it stole the plan, which was unique) and also solicited customers (which it had built over the years). a. A former employee may not solicit his former employers customers if those customers cannot be readily ascertained by means other than knowledge b/c of the employment. Where the customer list was secured by years of business effort & advertising, and the expenditure of time & money, constituting a part of the good will of a business. C. General Rules i. While an employee you can't compete with employer b/c you have a fiduciary duty ii. You can terminate the agency at will, however, so once you quit, you no longer owe a fiduciary duty & you can compete. a. Knowledge received by employment, reputation, etc. you can take this with you. What you can't do is walk away with a client list on paper. b. Reason: Otherwise, it would be like slavery either you stay with the same company forever, change careers, or pay royalties to previous employer. 1. Exception information thats confidential like patents. But this is addressed by non-competes (contract), so unnecessary to address in agency law. D. *This is different for lawyers soliciting clients, because the courts are concerned with preserving the clients right to chose their own lawyer. Not to protect lawyers right to solicit (although this is the practical effect) but rather the clients right the choose. (SEE P. 13 for more on grabbing and leaving) 8

PARTNERSHIPSI. Elements of a PartnershipA. 5 Elements of a Partnership UPA (Uniform Partnership Act) 6. Partnership is an association of "two or more persons to carry on, as co-owners, a business for profit." i. Association of two or more a. agreement necessary, but no written contract. Agreement is to associate, not to form a partnership. b. no formal partnership agreement required c. no governmental registration required d. If you fit the elements of a partnership, youre a partnership. ii. Persons a. Person can be a corporation (or any other business entity) or a natural person. Some "people" are not "persons" under definition of law - minors, etc. b. can't form a partnership with yourself, but you could with a corporation of which you were the sole shareholder. iii. As co-owners a. not employee/employer. iv. In a business a. Not a church, not a share of stocks b. co-ownership of a rental property as joint tenants is not enough v. For profit. a. Not-for-profits don't count b. Just b/c no profit made won't mean its not a partnership, as long as they intended to make profit B. UPA 7: Rules for determining existence of a partnership i. Joint tenancy/joint property/part ownership doesnt of itself establish partnership ii. Sharing of gross returns doesnt of itself establish a partnership iii. UPA 7(4) Receipt of a share of profits of a business is prima facie evidence of partnership, but no such inference shall be drawn if (exceptions): a. Wages or rent (even if calculated based on profit) - store may pay landlord rent based on profits of the store w/o landlord becoming its partner. b. Debt repayment - if business owes ex-partners money, this doesnt make them a partner, it makes them a creditor. c. Annuity to deceased partner - if you want to retire, your payments should not be based on profits; but they may be if you are dead. d. Interest - If you lend money to the partnership & take as interest a share of profits, you are not a partner. But if you invest money in the partnership & take a share of the profits, you are. 1. So what becomes important is the level of control. e. As consideration for sale - the distinction between allowing in a new investor and selling the business is going to be tough to make if the seller still receives a share of profits. C. Liability Rules of a partnership

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i. Profit Sharing Default Rule profits are split per person/partner, w/o regard to money or labor contribution. But you can change the default rule by agreeing to something else in the partnership agreement. ii. Splitting losses default rule - losses follow profits. So if you make agreement on profits, losses also split that way. a. 3rd party breach of K or torts - Sue the partnership & collect. But if partnership is insolvent? 1. Partners held jointly and severally liable for the obligations of the partnership (UPA 15). Each partner is a guarantor of the partnerships full debts. b. Partnership agreement can say how losses (debts) will be split. If agreement says Partner A is liable for 90% of debts, B 10% of debts, you can still sue B for full debt and collect. But then B can sue/collect from A the 90%. 1. Reasoning: 3rd parties entitled to rely on the entity, plus that each individual partner puts their individual credit behind the partnership. iii. UPA 9: Every partner is agent of the partnership for purpose of its business. The act of every partner for carrying on the usual way of business binds the partnership, unless he has no authority to act in particular manner and 3rd party knows. iv. UPA 13: Partnership liable for any wrongful act or omission of any partner acting in the ordinary course of the business or partnership or w/ authority of co-partners v. UPA 17: Person admitted into existing partnership liable for all obligations of the partnership arising before his admission vi. Federal Income tax purposes income and losses of the partnership are attributed to the individual partner; the partnership itself does not pay taxes.

II. Partners Compared with EmployeesA. UPA 42: The sharing of profits is prima facie evidence of partnership, but no such inference shall be drawn if such profits were received in payment as wages of an employee. B. Fenwick v. Unemployment Compensation Commission, - Chesire works for Fenwick & asks for a raise. Fenwick agrees only if hes making enough money, so he gets a lawyer to write an agreement, which said Chesire is a partner (so Chesire gets share of profits). Chesire leaves employment, & Fenwick refuses to pay into the unemployment fund b/c she wasnt an employee within the meaning of the statute. said the agreement was not a partnership agreement, but just an agreement fixing the compensation of the employee. Court held that no partnership created, the K was nothing more than a method to provide for compensation. Just b/c the agreement says they are a partnership, doesnt make it so. i. Court looks at the characteristics of a partnership: a. The intention of the parties just b/c K said partnership, doesnt make it so. The real reason for the K was to provide calculation for an increase in compensation, but to protect Fenwick in case he couldnt afford it. b. The right to share profits not every agreement that gives a right to shares profits is a partnership, so not conclusive. c. The obligation to share losses only Fenwick liable for debts of partnership. d. The ownership and control of the partnership property & business - Fenwick contributed all the capital & Chesire had no right to share capital upon dissolution. Fenwick also retained all control. 10

e. Community of power in administration - Fenwick had exclusive control of mgmt of the business. f. Language in the agreement K called it a partnership, but also excluded Chesire from most of the ordinary rights of a partner. g. Conduct of the parties towards third persons didnt hold themselves out as partners, she was still working as the receptionist. h. The rights of the parties on dissolution- No diff for Chesire than if she quit i. Co-ownership agreement only to share profits, Fenwick had ownership.

III. Partners compared with LendersA. The determination of whether a business organization constitutes a partnership is done on a case-by-case analysis of all factors to determine whether they reveal the intent to do business as co-owners; no single factor is dispositive. Thus, an explicit partnership agreement may be deemed not to create a partnership, and an agreement specifically denying a partnership exists may be found void. B. The sharing of profits is not conclusive evidence of a partnership. i. ***Martin v. Peyton, 246 N.Y. 213 (1927) - KNK, a partnership, was in financial difficulty, and Hall, a partner there, arranged for the s (Peyton + others) to loan them some securities, to be used as collateral for a bank loan to KNK. KNK creditors sued to get their money, and argued that the loan to KNK by s was actually a partnership agreement, so s would also be liable for KNK's debts b/c they were partners. Although the agreement said no partnership, the rule is to look at what actually is the case. Court looked at circumstantial evidence, & decided no partnership formed. a. Although profit sharing (which happened here) is considered an element of a partnership, not all profit-sharing arrangements indicate the existence of a partnership relationship. All of the features of the agreement are consistent with a loan agreement, so no partnership has been formed. b. Note: If KNK had been organized as a corporation, LLC, or LLP, s here would have avoided any risk of liability. Under those forms of business organization, as equity investors, s could not have been held personally liable for the firm's debts. c. ***While evidence of profit sharing is prima facie evidence of the existence of a partnership, it is not dispositve, and other factors may indicate no partnership was intended.

IV. Partnership by EstoppelA. General Rule: Persons who are not actual partners as to each other are not partners as to third persons. i. Exception: A person who represents, or who expressly or impliedly consents to such a representation, that she is a partner, is liable to any third person who extends credit in good-faith reliance on such representations. (UPA 16) B. Young v. Jones, 816 F.Supp 1070 (1992) Price Waterhouse Bahamas (PW-Bahamas) is Bahamian partnership, and price Waterhouse United States (PW-US) is a NY partnership. invests money in a company, based on an audit letter from PW-Bahamas, and later the money disappears. sues PW-Bahamas for negligence, and saying that b/c the 2 are partners by estoppel, PW-US is also liable. say b/c PW-Bahamas letterhead

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only identified it as Price Waterhouse & used that logo, and also b/c Price Waterhouse advertised that it had offices all over the world. i. Since the 2 firms are organized separately, there is no partnership in fact. ii. Also, there is no partnership by estoppel. doesnt contend that he relied on the advertising or letterhead in investing. Plus, the exception in UPA 16 only applies to reps made to 3rd person who give credit to the partnership. No credit was extended here, this is a case of liability for negligence. Also, didnt show that they relied on any conduct by PW-US that they had a partnership with PW-Bahamas.

THE FIDUCIARY OBLIGATIONS OF PARTNERSI. The Fiduciary Obligations of PartnersA. Each partner has a fiduciary duty to all other partners. i. The only fiduciary duties a partner owes to the partnership & the other partners are the duty of loyalty & the duty of care. (UPA 404). a. A partners duty of loyalty is limited to the following: 1. every partner must account to the partnership for ANY benefit and hold in trust all profits derived by or for the partnership 2. refrain from dealing with the partnership in conduct or winding up as or on behalf of an party with adverse interest to the partnership 3. refrain from competing with the partnership before dissolution b. A partners duty of care is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law. c. Partner required to act in good faith and fair dealing with regard to the partnership & other partners d. A partner does not violate a duty or obligation merely because the partners conduct furthers the partners own interest (partner CAN further his own interests). e. A partner may lend money to and transact other business with the partnership & with regard to these transactions, the rights and obligations of the partner is the same as if he was not a partner. ii. Unless otherwise agreed (default), books of the partnership shall be placed at the principal place of partnership's business & all partners shall have access to the books at any time (UPA 19). iii. All partners shall render information affecting the partnership to other partners (UPA 20) B. Partners in a business have a fiduciary duty to inform one another of business opportunities that arise. Joint venture partners owe each other the highest obligation of loyalty as long as their venture continues. i. ***Meinhard v. Salmon, Salmon leased a hotel from Gerry for a term of 20 yrs; Salmon needs financing, & enters into a joint venture (partnership, but never actually called that) with Meinhard who would pay the money needed for this, and would receive 40% of the profits for 5 yrs, and 50% after. Salmon had the sole power to manage the property & no interest in the lease ever assigned to Meinhard. Towards 12

the end of the lease, Gerry approaches Salmon with a new, bigger opportunity, and Salmon enters this other lease w/o telling Meinhard. Meinhard finds out and demands he be let in on the new deal b/c the opportunity to renew the lease belonged to the joint venture. a. Holding: Meinhard gets % of the shares of the new deal. 1. Salmon (managing partner) owed Meinhard (investing partner) a fiduciary duty, and that this included a duty to inform Meinhard of the new leasing opportunity. Joint venturers owe each other the highest duty of loyalty, and the duty is even higher for a managing co-adventurer, b/c Meinhard relied on him to manage the partnership. 2. There was a close nexus between the original joint venture and the new opportunity, since it was essentially an extension & enlargement of the subject matter of the old one. This would be diff if the new opportunity didnt involve the same thing. 3. Salmon was also an agent of the joint venture, and this new opportunity was only made available because he held that position in the joint venture. Salmon would never have had this opportunity were it not for Meinhards initial investment. 4. This case extended the duties of partnership far beyond duties under contract. b. Dissent: This isn't a partnership (where the majority would be correct), its a joint venture, which is a partnership for a very limited purpose & contemplated that it would end at a certain time. Where the parties engage in a joint enterprise each owes to the other the duty of good faith in all that relates to their common venture. Their fiduciary relationship only exists within that scope.

II. After DissolutionA. A partner who retires ceases to be a partner, and his former partners no longer owe him a fiduciary duty. a. Partners can't do anything that makes it impossible to carry on the ordinary business of the partnership, unless authorized by all the partners (UPA 9(3)(c)). Also, a partner is a fiduciary of his partners, & owes this duty against negligence. But neither apply here, b/c Bane was no longer a partner once he retired. The only complaint he could have had was if there was fraud or deliberate misconduct (where no fiduciary relationship is necessary). 1. The business judgment rule protects the firm from liability for mere negligent operation.

III. Withdrawing Partners Removing Clients from Firm (Grabbing and Leaving)A. Fiduciaries may plan to compete with entity to which they owe allegiance, provided that in the course of these arrangements they dont otherwise act in violation of fiduciary duties. i. Partners owe each other fiduciary duty of "utmost good faith and loyalty," must consider other partners' welfare & refrain from acting for purely private gain. ii. A partner has an obligation to render on demand true and full information of all things affecting the partnership to any partner iii. Meehan v. Shaughnessy, 535 N.E.2d 1255 (1989) 2 partners in a law firm were planning to leave & set up their own firm. They asked another partner & some 13

associates to leave with them. They had a list of cases they were going to take with them & sent out letters to the clients to consent to removal of their files from the firm. As they were preparing to leave, they denied that they were leaving when asked by the partners. a. The fiduciary duty of a partner does not prevent that partner from secretly preparing to start his own law firm. But they breached their duty of loyalty by acting in secret and obtaining an unfair advantage over the firm by (1) denying (lying) they were leaving, (2) preparing notices to go out immediately (before firm could compete) to the clients, and (3) delaying to provide the firm with a list of clients they intended to solicit until they had already obtained authorization from most of them. The also gave less notice than required (30 days instead of 90). Also, the letters to the clients were unfairly prejudicial it did not indicate to the clients that they had a choice on whether to remain with the firm, but only that they were leaving and needed permission to remove the files from the firm.

IV.

Expulsion of a Partner

A. Dissolution is caused: (1) without violation of the agreement between the partners, (d) by the expulsion of any partner from the business bona fide in accordance with such power conferred by the agreement between the partners. [UPA 31]. When a partner is involuntarily expelled from a business, his expulsion must be bona fide or in good faith, for a dissolution to occur without violation of the partnership agreement. B. Lawlis v. Kightlinger & Gray, 562 N.E.2d 435 (1990) Lawlis was a senior partner in a law firm and began using alcohol, so he didnt practice for several months b/c of this, & b/c he was seeking treatment. He later informed his partners of his problems, and they set forth some conditions with no 2nd chance. When he relapsed, they did give him a 2nd chance, where if he met certain conditions, they would return him to full partnership status. He didnt consume alcohol after that. However, Lawlis was then told they would recommend his expulsion & a few days later the firms files were removed from his office. Lawliss expulsion was voted on by a majority vote of the senior partners, as per the partnership agreement. i. Lawlis claims that the notification of the impending recommendation of expulsion & removal of files was a dissolution of the partnership, and this was wrongful b/c it wasnt authorized by the majority vote. a. Court disagrees. Everyone still considered him a partner even after this, and Lawlis still acted like a partner. The notification was merely to say what they planned to do. The dissolution occurred when they voted by majority for his expulsion, in accordance with the partnership agreement. ii. Lawlis also claims that his expulsion was a breach of the fiduciary duty between partners, which requires each to exercise the duty of good faith and fair dealing b/c he was expelled for the predatory purpose of increasing the firms lawyer-to-partner ratio. a. Court disagrees. When the firm found out about the alcoholism problem, it sought to help him, even though he was taking substantial time off work. Even after he violated the conditions set forth at first, the firm still gave him a 2nd chance. And instead of recommending immediate expulsion, the firm proposed to allow him to stay for a while so he could find other employment & retain insurance coverage. 14

PARTNERSHIP PROPERTY, RAISING CAPITAL & RIGHTS OF PARTNERS IN

MANAGEMENTI. Partnership PropertyA. What constitutes partnership property? Issue is whether property is partnership property or the individual property of the partner. All property originally brought into the partnership or subsequently acquired, by purchase or otherwise, for the partnership, is partnership property. [UPA 8(1)] i. Where there is no clear intention expressed as to whether property is partnership property, then courts consider all the facts related to the acquisition and ownership of the asset. Some of the factors considered are: a. How title to the property is held b. Whether partnership funds were used in the purchase of the property c. Whether partnership funds have been used to improve the property d. How central the property is to the partnerships purposes e. How frequent and extensive the partnerships use is of the property f. Whether the property is accounted for on the financial records of the partnership. B. Rights and Interests i. The property rights of an individual partner in the partnership property are (i) her rights in specific partnership property, (ii) her interest in the partnership, and (iii) her right to participate in the management of the partnership. [UPA 24] a. Each partner is a tenant-in-partnership with her co-partners as to each asset of the partnership [UPA 25(1)] (Each partner, collectively, owns the whole partnership). 1. Each partner has an equal right to possession for partnership purposes (but no right to partnership property for any other purpose w/o consent of all other partners). 2. The right to possession is not assignable, except when done by all the partners individually or by the partnership as an entity 3. The right is not subject to attachment or execution except on a claim against the partnership 4. The right is not community property 5. On the death of a partner, the right vests in the surviving partners. b. A partners interest in the partnership is her share of the profits and surplus, which is personal property. [UPA 26] 1. A partner may assign her interest in the partnership and such assignment will not dissolve the partnership (unless partnership agreement says otherwise). [UPA 27(1)] (a) The assignee has no right to participate in the management of the partnership. But the assignee is liable for all partnership obligations. (b) C. Co-partners do not own any asset of the partnership; the partnership owns the asset and the partners own interest in the partnership. The interest is an undivided interest.

II. Raising Additional CapitalA. Partnerships sometimes need to raise additional capital to finance their activities. Sometimes the issue is addressed in the partnership agreement itself. Examples: i. Pro rata dilution provision permits a call to each partner for a certain sum and provides for a reduction in partnership shares of any partner who does not contribute the requested sum. ii. Provision might allow partners to invest in the firm at a reduced price or require partners to make loans that will bear interest at a higher rate. iii. May provide for the sale of new partnership assets to people outside the partnership, similar to a corporations placing new shares on the stock market. 15

III.

The Rights of Partners in Management

A. UPA 18 sets out basic rights and duties, but these are default rules which can be changed by agreeing otherwise (in partnership agreement). i. 18(a) Equal shares of profits per person. Losses follows profits. ii. 18(b) if a partner advances money on behalf of partnership, the partnership needs to indemnify (b/c its the partnerships expense, and partnerships liabity). iii. 18 (c, d): a. The distinction between contributions and loans. b. No interest on capital contributions. iv. 18(e): All partners have equal rights in management equal votes (even if sharing of profits is unequal). Meaning a voice, a right to information, and a right to vote. v. 18 (f): No partner entitled to salary for acting in partnership business vi. 18(g): black ball rule need unanimous vote of all existing partners to become a partner. vii. 18(h): Any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners. viii. 18(i): Distinction between legislative and constitutional matters a. Constitutional matters - things that require change in partnership agreement requires unanimous consent (this rule can't be changed) b. Legislative matters (ordinary matters) - decided by majority vote (this is a default rule, it can be changed in the partnership agreement). B. The acts of a partner within the scope of the partnership business bind all partners; all partners are severally and jointly liable for the acts and obligations of the partnership (unless no authority to act & 3rd party knows the restriction). Partner who is sued con then sue for percentage of contribution from other partner. A majority of partners can make a decision and inform creditors and will thereafter not be bound by acts of minority partners in contravention of the majority decision. i. National Biscuit Company v. Stroud, P.140 (1959) Stroud and Freeman enter into a partnership to sell groceries. There were no restrictions in the partnership agreement on the management functions or authority of either partner. Stroud notifies Biscuit ( ) that he would not be responsible for additional bread delivered. But Freeman orders bread, Biscuit delivers it. Partnership is dissolved, Stroud responsible for winding up partnerships affairs, and refuses to pay Biscuit. a. Court holds that Freemans purchases of bread bound the partnership. The purchase was an ordinary matter connected with the partnership business within the scope of the business and Stroud could not be a majority (b/c only 2) of the partners to make a decision otherwise. C. Where equal partners exists, differences on business matters must be decided by a majority of the partners. i. Summers v. Dooley, 481 P.2d 318 (1971) Summers & Dooley form partnership to operate trash collection business. Summers wants to hire a 3rd person to help, but Dooley says no. Summers hires someone anyway & paid him from his own funds. Dooley finds out & objects. Summers then sues Dooley for reimbursement from partnership funds for money paid to the 3rd person. a. Dooley refused consent to hire the 3rd person & objected when he found out Summers still did. A partner who has actively opposed expense incurred 16

individually and for the benefit of one partner rather than partnership as a whole is not liable for the cost D. Partnerships are distinct entities from their partners. A partnership must indemnify a partner for injuries that occurred in the ordinary course of the partnership business. There is no corresponding right of indemnity for the partnership against the partner. E. The essence of a breach of fiduciary duty between partners is that one partner has advantaged himself at the expense of the firm. i. The basic fiduciary duties are: a. a partner must account for any profit acquired in a manner injurious to the interests of the partnership, such as commissions or purchases on the sale of partnership property; b. a partner cannot without the consent of the other partners, acquire for himself a partnership asset, nor may he divert to his own use a partnership opportunity; and c. he must not compete with the partnership within the scope of the business ii. Day v. Sidley & Austin, 548 F.2d 1018 (1976) Day was a senior partner & chairman at Sidley, and signed an agreement for the firm to merge with another firm. Then they set up a new location, despite Days objection. Day then resigned, saying the relocation & appointment of a new co-chairman made his continued service with the firm intolerable. a. Day alleges misrepresentation by Sidley that no partner would be worse off because of the merger, & he was worse off b/c no longer sole chairman. But Day had no legal right for Day to remain chairman of the DC office. Also, even if he did know this to begin with, & he changed his vote, it would have no effect, b/c all that was needed was majority vote (not unanimous). b. Day also alleges breach of Sidleys fiduciary duty b/c they began the merger negotiations w/o informing all partners & didnt reveal changes that might occur b/c of the merger. But the only breach would be if one partner has advantaged himself at the expense of the firm, and this wasnt the case here. Concealing merger plans didnt produce profit for the other partners or financial loss for partnership as a whole.

PARTNERSHIP DISSOLUTIONI. DissolutionA. Dissolution of a partnership does not immediately terminate the partnership. The partnership continues until all of its affairs are wound up. [UPA 30] B. Causes of Dissolution: Unless otherwise provided in the partnership agreement, the following may result in dissolution: i. Expiration of the partnership term a. Even if partnership is for a fixed term, partners can still terminate at will. But since this will be breach the other partners can sue for damages. ii. Any partner can terminate the partnership at will (b/c a partnership is a personal relationship which no one can be forced to maintain). Where the partnership is for a 17

term or where it is a partnership at will but the dissolution is motivated by bad faith, it may be a breach of the agreement. iii. Assignment. Although an assignment of a partners interest is not an automatic dissolution, an assignee can get a dissolution decree upon expiration of the partnership term or at any time in a partnership at will [UPA 30-32]. iv. Death of a partner. On the death of a partner, the surviving partners are entitled to possession of the partnership assets and are charged with winding up the partnership affairs without delay [UPA 37]. The surviving partners are also charged with a fiduciary duty in liquidating the partnership and must account to the decedents estate for the value of the decedents interest. v. Withdrawal or admission of a partner. Partnerships only exist if same partners. a. This only works if very few partners, where one person makes a difference. But in a large partnership, it doesnt work every time one partner leaves the partnership changes. This is a default rule, which you can change. b. Most partnership agreements provide that losing or admitting a new partner will not result in dissolution. New partners may become parties to the preexisting agreement by signing it at the time of admission to the partnership [UPA 13(7)]. When an old partner leaves, there are usually provisions for continuing the partnership and buying out the partner who is leaving. vi. Illegality. Dissolution results from any event making it unlawful for the partnership to continue in business. vii. Death or Bankruptcy. (Default rule) The partnership is dissolved on the death or bankruptcy of any partner [UPA 31(4), (5)] viii. Dissolution by court decree. Court may do this in its discretion. Some circumstances may be insanity of a partner, incapacity, improper conduct, inevitable loss, or whenever it is equitable [32].

II. The Right to DissolveA. Dissolution by court decree Significant disagreement between partners that undermines the business of the partnership, makes it impossible to continue i. On application by or for a partner the court shall decree a dissolution whenever (c) A partner has been guilty of such conduct as tends to affect prejudicially the carrying on of business, or (d) A partner willfully or persistently commits a breach of the partnership agreement or otherwise so conducts himself in matters relating to the partnership business that it is not reasonably practicable to carry on the business in partnership with him. [UPA 32]. a. Owen v. Cohen, 119 P.2d 713 (1941) and were partners in a bowling alley, with no duration time set. loans the partnership $6,986 to be paid back to him from prospective profits. Bowling alley running at a profit, but then the partners started having disagreement over how the business should be run, and these conflicts affected the profitability. sues for dissolution. 1. Court found that s actions severely undermined the success of the partnership. There were bitter, antagonistic feelings between the parties while the arrangement required cooperation, coordination & harmony. The partners were no longer able to carry on the business of their mutual partnership. B. There is no such thing as an indissoluble partnership only in the sense that there always exists the power, as oppose to the right, of dissolution. But without a legal 18

right to dissolution, there will be damages because it is a breach of the partnership agreement. i. Collins v. Lewis, 283 S.W.2d 258 (1955) and entered into partnership to operate a cafeteria. was to finance the project & was to supervise development & manage it. would be paid back from the profits, and the rest of the profits would be split equally. When they opened, they were not making a profit. said it was because refused to pay additional development costs, so that money was coming out of the revenue. sued for dissolution. a. has the power to dissolve the partnership, but not the right to do so without damages since his conduct is the source of the partnership problems and amounts to a breach of the partnership agreement. C. A partner at will is not bound to remain in a partnership, regardless of whether the business is profitable or unprofitable. Exercising the power to dissolve, however, must be exercised pursuant to the fiduciary duty of good faith.

III.

The Sharing of Losses

A. In the absence of an agreement to the contrary, it is presumed that partners and joint venturers intended to share equally in profits and losses. However, where one partner or joint venturer contributes the capital while the other contributes skill and labor, neither party is liable to the other for losses. (The reason behind this rule is that in the event of loss, each party loses the value of his own capital or contribution). B. RUPA (1997) 401(b) expressly cites and rejects Kovacik: Each partner is entitled to an equal share of the partnerships profits and is chargeable with a share of partnership losses in proportion to the partners share of the profits. [losses follow profits]

IV.

Buyout Agreementsi.

Because partnerships result from contract, the partners rights and liabilities are subject to the agreement made among them. The agreement here provided for a buyout if one of the partners died. Although the exact provision in the agreement calculated the value of the interest as less than the fair market value, court says that parties must be bound by the contracts into which they enter, absent a showing of fraud or duress in the inducement. a. Buyout provision here if the remaining partners choose to continue the business, it must purchase the interest of the departed partner (interest that belongs to the estate). Here, the buyout formula is the capital account of the deceased partner plus the average of the prior 3 yrs earnings. (Capital acct = partners capital contribution to partnership minus losses and reduced by any distributions already made). B. Four main aspects of the buyout agreement: a. Trigger Events 1. Death 2. Disability 3. Will of any partner b. Obligation to buy versus option 1. Firm 2. Other investors 19

c.

d.

e. f.

3. Consequences of refusal to buy (a) If there is an obligation (b) If there is no obligation Price 1. Book value (assets-liability/ number of shares) 2. Appraisal (but who does the appraising?) 3. Formula (e.g. five time earnings) 4. Set price each year 5. Relation to duration (e.g. lower price in first five years) Method of payment 1. Cash 2. Installments (with interest?) Protection against the debts of partnership Procedure for offering either to buy or sell 1. First mover sets prices to buy or sell 2. First mover forces others to set price

C. Other ways to create a system for determining the price of the buyout i. If both parties solvent, set it up where one party names the price, and the other decides whether to buyer. This is the most fair outcome. (think about 2 little children sharing a piece of cake one cuts it in half, the other gets to choose which half. This way the one cutting will try to be as fair as possible cutting it equally). ii. Appraisal - but must determine what kind of appraisal a. Each side picks an appraiser, and the 2 appraiser pick a 3rd appraiser (that's if they have money) iii. Base the amount on gross revenues a. Small business, less money - most common formula is book value 1. Book value - something you need to generate anyway. But problem is that the book value can easily be manipulated - must trust the accountant. iv. Buy life insurance on the dead partner to ensure the dead partner is solvent D. Limited partnerships i. Holzman v. De Escamilla a. Limited partner took control in business by controlling the funds and planting, thus became exposed for the liability of the general partners. b. Rule of Law: A limited partner will be held liable as a general partner if the limited partner acts to take part in the control of the business 1. So what do you do if you want to control and protection? They should for an LLC or an S type corporation.

NATURE OF THE CORPORATION20

I. Promoters and the Corporate EntityA. Southern-Gulf Marin Co. No. 9. Inc. v. Camcraft, Inc. i. Basically you have to treat corporations fairly even before true incorporation. Even if the papers are filed improperly. What is important is what the other party thought, e.g. the other party was a corporation by estoppel. ii. Rule of Law: A party can not justify the nonperformance of a contractual obligation by the other partys lack of corporate capacity or the lack of stated corporate capacity a. Minority interest in a privately held company is one of the worst positions you can have. Way to protect interest is that Ill make the investment, but need to make sure that under certain circumstances that the company need to buy out my shares at a fair price Firm obligation to buy back b. Hypo: Represent large corporation that is trying to purchase large tract of land. Framers would charge more is they knew who the buyer is. However, it is set up so he will not know. He has no right to know, and will not be told so.

II. The Corporate Entity and Limited LiabilityA. Characteristics of the Corporation i. Separate Legal Entity. A corporation is a separate legal entity (created by the law of a specific state), apart from the individuals that may own it (shareholders) or manage it (directors, officers, etc.). Thus, the corporation has legal rights and duties as a separate legal entity. ii. Limited Liability. The owners (shareholders) have limited liability; debts and liabilities incurred by the corporation belong to the corporation and not to the shareholders, since they are separate legal entities. (Also vice versa, corporation not responsible for debts of shareholders.) iii. Continuity of existence. The death of the owners (shareholders) does not terminate the entity, since shares can be transferred. iv. Management and control. Management is centralized with the officers and directors. Each is charged by law with specific duties to the corporation and its shareholders. v. Corporate powers. As a legal entity, a corporation can sue or be sued, contract, own property, etc. B. Exceptions to the Limited Liability Rule In some circumstances, the court may pierce the corporate veil and dissolve the distinction between the corporate entity and its shareholders so that the shareholders may be held liable as individuals despite the existence of the corporation. i. Fraud or Injustice. Where the maintenance of the corporation as a separate entity results in fraud or injustice to outside parties (i.e. creditors). ii. Disregard of corporate requirements. Where the shareholders do not maintain the corporation as a separate entity but use it for personal purposes. The rationale is that if the shareholders have disregarded the corporate form, then the entity is really the alter ego of the individuals and decisions made are for their benefit and not the entitys. This is most likely to occur with close corporations. 21

iii. Undercapitalization. Where the corporation is undercapitalized given the liabilities, debts, and risk it reasonably could be expected to incur. iv. Fairness. The veil may also be pierced in any other situation where it is only fair that the corporate form be disregarded.

III.

Piercing the Corporate Veil

A. Piercing the corporate veil is allowed whenever necessary to prevent fraud or to achieve equity. Whenever anyone uses control of the corporation to further his own, rather than the corporations business, he will be liable for the corporations acts. i. Walkovsky v. Carlton, 18 N.Y.2d 414 (1966) was severely injured in a taxicab accident, and sues the cab driver, the corporation owning the cab, and the . owned that corporation and 9 others, each corporation had 2 cabs each with the min $10k liability insurance coverage required by state law. alleged that the corporations operated as a single entity & constituted a fraud to the public. a. Court says no reason to pierce the corporate veil. 1. (1) Nothing wrong with one corporation being part of a larger corporate enterprise (i.e. subsidiary). The only issue would be whether there was a disregard of the corporate form, but did not allege this. (2) (Undercapitalization) The state has set minimum insurance requirements & all other cab corporations have taken out the min insurance. If insurance protection is inadequate, the remedy is the legislature. b. Dissent: Corps were intentionally undercapitalized to avoid responsibility for accidents, which were likely to happen. All income was continuously drained for this purpose. B. Alter Ego theory Two requirements must be met before the corporate veil can be pierced: (1) such a unity of interest and ownership that the corporation and the individual are not separate personalities, and (2) circumstances are such that not piercing the veil would sanction a fraud or promote injustice. i. To determine whether a corporation is so controlled by an individual or another corporation that the court would be justified in disregarding their separate identities, courts looks to four factors: a. The failure to comply with corporate formalities or to keep sufficient business records b. A commingling of corporate assets c. Undercapitalization; and d. One corporations treatment of another corporations assets as its own. ii. Sea-Land Services, Inc. v. Pepper Source, 941 F.2d 519 received a judgment from Sea-Land for breach of contract, but when attempted to collect, Sea-Land was dissolved. sues Sea-Lands sole shareholder ( ) and s other business entities. wanted to pierce Sea-Lands corporate veil so that could be held personally liable, then reverse pierce s other corporations (to get the money the other corporations have). Court held that the corporate veil could be pierced. a. Unity of interest and ownership - There was no differentiation/separation between the corporation and the owner. used same office, same phone line, & expense acct to run most of the corporations. None of the corporations ever held a meeting. borrowed funds from corporation for personal expenses, and the 22

corporations would borrow money from each other. didnt even have a personal bank acct. b. Separate corporate existences would sanction a fraud or promote injustice - must be something more than just a creditor not being able to recover. 1. Comment: On remand, court found in s favor, b/c by receiving countless benefits at the expense of and other creditors, insured that his corporations had insufficient funds with which to pay their debts. iii. When a parent corporation controls several subsidiaries, a subsidiary is not liable for the actions of the other subsidiaries. a. Roman Catholic Archbishop of San Francisco v. Sheffield, 15 Cal.App.3d 405 (1971) goes t Switzerland and contracts to buy a dog for $175 from a Catholic monastery, to be paid in $20 installments. makes 2 payments. Monastery refuses to ship the dog until all payments made, plus additional fees, and refuses to refund the money. sues the Roman Catholic Church (parent), the Roman Catholic Archbishop of San Francisco (subsidiary) & others. 1. Unity of interest and ownership - was a distinct legal entity from the monastery had no knowledge of the contract, and no dealings with the monastery. did not allege that was involved in the transaction. Although the monastery may have been an alter ego of the Catholic Church, thats not the case here. There is no respondeat superior between subagents. 2. Non-piercing would sanction fraud or promote injustice Not enough that won't be able to collect if not permitted to sue . iv. A parent corporation is expected to exert some control over its subsidiary. When, however, a corporation is controlled to such an extent that it is merely the alter ego or instrumentality of its shareholder, the corporate veil should be pierced in the interest of justice. a. In Re Silicone Gel Breast Implants Products Liability Litigation, 887 F.Supp. 1447 (1995) is the sole shareholder of MEC (they have a parent-subsidiary relationship). highly involved in MECs daily operations. MEC sued in tort & s want to pierce the veil & hold parent liable. 1. There is sufficient evidence here that MEC is s alter ego. 2. To determine if a subsidiary is merely the alter ego of the parent, the court must evaluate the totality of the circumstances, considering factors above (see sea-land) [first five in this case always happen: (1) same directors or officers, (2) they file consolidated taxes, (3) the subsidiary is undercapitalized, (4) the subsidiary gets all its business from the parent, (5) the parent uses the subsidiarys property for its own, (6) the parent pays expenses or wages for the subsidiary, (7) their daily operations are commingled.] b. To determine whether to pierce the veil in a parent-subsidiary situation, no showing of fraud is required under DE law. Most states that require fraud only do so in contracts cases, not torts. 1. Even if fraud required MECs funds may be insufficient to satisfy s claims. Also, may have induced ppl to believe it was vouching for MEC, so allowing to escape liabily would be unjust.

23

C. Limited partners do not incur general liability for the limited partnerships obligations simply because they are officers, directors, or shareholders of the corporate general partner. Undercapitalization is no reason to open liability to limited partners who control the general partner, but theres the remedy of piercing the corporations veil. i. Frigidaire Sales Corporation v. Union Properties, Inc., 88 Wash.2d 400 (1977) Commercial is a limited partnership. s were limited partners of Commercial, and the only general partner was Union, a corporation. s were also Unions officers, directors, and shareholders. Commercial breached contract with ; and wants to pierce Unions veil to make s liable. a. Just b/c undercapitalized, can't go after the partners in Commercial. Need to pierce the corporations veil. But here, no reason to pierce Unions veil. entered into K with Commercial, and s signed the contract only through their capacities as officers of Union (Commercials general partner). Court refused to pierce veil, and found that s scrupulously separated their actions on behalf of Union from their personal actions, and never had cause to believe s were general partners in Commercial. ii. Contract vs Tort Courts are more willing to pierce the veil b/c of undercapitalization in tort cases than in contract cases. This is b/c in K cases, the had an opportunity to investigate the financial resources of the corporation & had chosen to do business with it. Almost like assumption of the risk.

24

SHAREHOLDER DERIVATIVE ACTIONI. Shareholder Derivative & Direct ActionA. Two Types: i. 145(a) Personal claims covers expenses, judgment, and settlement ii. 145(b) derivative claims covers only expenses (maybe, only if settlement, not a judgment) B. Derivative Suits. A shareholder may sue to enforce mgmts duties. If the claim is that mgmts breach reduced the residual value of the business, the shareholder must due derivatively in the name of the corporation. i. Problem - A person with a relatively small stake in the residual value of a business might want to bring derivative suit just to be bought off. Requiring the s to make payment to the corporation reduces this temptation for the complaining shareholder. The real party in interest here though, is the shareholders attorney, b/c he may legitimately demand payment from the corporation in connection with a settlement. C. Limiting Derivative Strike Suits i. In order to limit strike suits and otherwise protect against over-deterrence, most statutes limit shareholders who may bring derivative suits, and many states have enacted statutes requiring the -shareholder in a derivative suit, under certain circumstances, to post a bond or other security to indemnify the corporation against certain litigation expenses if loses the suit. a. When security must be posted. Depends on the statute; some say when owns less than a specified % of stock; others say it is at the courts discretion (& demanded only when there is no reasonable possibility that the action could benefit the corporation). b. Who is entitled to security. In most states, only the corporation may demand security & only its expenses may be paid. Some states allow directors/officers to demand it & receive reimbursement. c. Covered Expenses. Usually all expenses, including attorneys fees. Also expenses of officers/directors that the corporation has obligated to pay b/c it has indemnified them may be covered (indemnification doesnt usually apply for fraudulent actions, only for actions taken in good faith). ii. Cohen v. Beneficial Industrial Loan Corp., 337 U.S. 541 (1949) brings derivative action in federal court in NJ against Beneficial & some of its mgrs/directors ( s), alleging that s engaged in conspiracy to enrich themselves at the corporations expense. owned only .0125% of the total stock. NJ statute required less than 5% shareholders who bring a derivative action to post a security bond; the lower court here required the bond and appealed. a. A stockholder who brings a derivative action assumes a position of a fiduciary nature. He sues as a representative of a class that did not elect him as a representative as they elected the corporate director or manager. The state has plenary power to impose standards promoting accountability, responsibility, and liability upon such representation. b. Constitutionality 1. Doesnt violate due process clause since it only imposes liability & requires security only for reasonable expenses. 25

D.

E.

F.

G.

2. Doesnt violate the equal protection clause by making a classification based on the financial interest the representative has in a corporation; the classification serves only to insure some measure of good faith and responsibility. c. Erie Doctrine using state law in federal court under diversity jurisdiction. The statute is substantive, so federal court will apply NJ statute. Direct Suits - If the claim is that mgmts breach deprived the shareholder of some other right (like right to inspect shareholder list), the shareholder must sue directly in her own name. i. If the -shareholder brings suit alleging that management is interfering with the rights and privileges of stockholders and is not challenging managements acts on behalf of the corporation, it is a personal suit. Since this is not a derivative action, posting of a security bond is not required. a. Eisenberg v. Flying Tiger Line, Inc., 451 F.2d 267 (1971) shareholder brings suit to prevent merger & reorganization, alleging that the purpose of the plan was to dilute his voting rights. Lower court demanded that the post a security bond & appeals. 1. is not challenging mgmt of the company on behalf of the corporation; claims that he has been deprived of any voice in the operation of their company. Therefore, the Court held that the action was personal, and not a shareholder derivative action, so no bond is required. The statute only applies to derivative actions. Note on Settlements and attorney fees i. When derivative suits reach settlement rather than proceeding to judgment, the company can pay the parties attorneys fees. When a judgment is rendered against the s, however, except as covered by insurance, the s generally will be responsible for attorneys fees and possibly costs. Often, the real beneficiary on the s side is his attorney, who may accept a generous fee from the corporation to settle the lawsuit while the corporate managers who brought harm on the corporation are relieved of the risk of personal loss. Note on Individual Recovery in a Derivative Action i. In Lynch v. Patterson (1985), the , one of 3 shareholders, brought a derivative suit against the other shareholders who, in managing the corporation, had increased their own salaries, ultimately paying themselves an extra $266k. The court awarded the damages in his individual capacity, reasoning that allowing a corporate recovery would merely put the funds back in the hands of the wrongdoers. The Demand Requirement. In order to deter frivolous suits, a complaining shareholder is required to exhaust internal remedies before bringing suit. So before a shareholder may bring a derivative suit, he must request that the directors bring the suit, and they must refuse. Now the Business Judgment Rule comes into play if the directors refuse on the basis of a good faith business judgment, the ct will dismiss the derivative suit. However, directors may sometimes refuse in bad faith. i. Purpose of the demand requirement: a. Creates a form of alternative dispute resolution by providing corporation directors with opportunities to correct alleged abuses,

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b. Helps insulate directors from harassment by litigations on matters clearly within the discretion of directors, and c. Discourages strike suits commenced by shareholders for personal gain rather then for the benefit of the corporation. ii. When a claim of harm belongs to the corporation, it is the corporation, through the Board, that must decide whether or not to pursue the claim. Shareholder derivative actions impinge on the Boards managerial freedom; therefore, when a shareholder files a derivative action, he/she must show either Board rejection of his/her pre-suit demand, or justification why demand wasnt made (Futility Exception). a. Grimes v. Donald, 673 A.2d 1207 (1996) -shareholder claimed that the Bd of Directors failed to use due care, committed waste, approved excessive compensation, and unlawfully delegated its duties & responsibilities by entering into an agreement with the CEO which provided that the CEO could make decision w/o interference from the Bd, & if Bd did interfered, CEO could get damages. 1. An abdication claim can be stated by a stockholder as a direct claim, as distinct from a derivative claim, but here the complaint fails to state a claim upon which relief can be granted. When a stockholder demands that the board of directors take action on a claim allegedly belonging to a corporation and demand is refused, the stockholder may not thereafter assert that the demand is excused with respect to other legal theories in support of the same claim, although the stockholder may have a remedy for wrongful refusal or may submit further demands which are not repetitious. iii. Futility Exception to the demand requirement: no demand necessary when it is evident that directors will wrongfully refuse to bring such claims. a. To qualify for the futility exception, a shareholder must allege with particularity that: 1. Self-Interest. A majority of the bd of directors is interested in the challenged transaction, by virtue of self-interest in the transaction or control by a selfinterested director 2. Incapacity. that the bd of directors did not fully inform themselves about the challenged transaction to the extent reasonably appropriate under the circumstances, or 3. Lack of sound business judgment. that the challenged transaction was so egregious on its face that it could not have been the product of sound business judgment of the directors. b. Marx v. Akers, (Not Done In Class) Without making a demand on Bd of IBM ( ), filed a shareholder derivative suit alleging that the Bd had wasted corporate assets by awarding excessive compensation to IBMs exec officers & to its outside directors. 1. Excessive compensation paid to exec officers - no futility. Less than a majority of the directors recd such compensation, indicating that the bd was not interested. 2. Excessive outside director compensation futility (yes). The outside directors comprised a majority of the Bd indicated that a majority of the Bd was self27

interested. So demand here is excused, but ct dismissed the complaint b/c there was no wrong to the corporation. (a) No cause of action did not allege compensation rates excessive on their faces or other facts that would have questioned whether the compensation was fair to the corporation when approved, the good faith of the directors setting those rates, or that the decision to set the compensation could not have been a product of valid business judgment. H. The Role of Special Committees Bd of Directors may create a special independent committee composed of disinterested directors to decide on whether to bring the derivative action. i. A Board may legally delegate authority to a committee of disinterested directors when the Board finds that it is tainted by the self-interest of a majority of directors. The Bd is not abdicating b/c the decision to create a committee is revocable. ii. An action must be dismissed if a committee of independent and disinterested directors conducted a proper review, considered a variety of factors and reached a good-faith business judgment that the action was not in the best interest of the corporation. iii. A committee must show that (i) its members are disinterested and used proper methodology, (ii) the committee is independent, (iii) it proceeded in good faith, and that (iv) it reasonably investigated the claim (procedural due process). a. If it recommends no lawsuit then usually loses (see Zapata case) b. In Re Oracle Corp. Derivative Litigation, 824 A.2d 917 (2003) -shareholders file derivative suit alleging insider trading by 4 members of the Bd. Bd forms special litigation committee to investigate. The 2 Bd members who were named on the committee joined the Bd after the events alleged took place & were both Stanford professors. The committee also got expert advisors to help investigate. After the committee conducted an extensive investigation, they concluded that the corporation should not pursue the derivative suit. Issue is whether this was an Independent & Disinterested Committee. (a) Facts revealed during discovery: (i) one of the -director was prof to one of the committee members & they have remained in contact with each other & both served on a Stanford committee, (ii) another -director wellknow alumnus of Stanford & generous contributor, (iii) yet another director had made major charitable contributions to Stanford. (b) Although none of the s could deprive the committee members of their prof positions at Stanford b/c they have tenure, ct notes that its not the only motivating factor of human behavior. Social influence may also direct behavior. The committee has not met its burden of showing their independence. The ties here are substantial enough to raise a reasonable doubt about the committees ability to impartially decide whether the derivative suit against the s should proceed.

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CORPORATE ROLE & PROFIT MAXIMIZATIONI. The Role and Purpose of the CorporationA. Corporate Purpose and Power i. Corporations must have a purpose or goal. So the question is What purposes are within the bounds set by the articles of incorporation and statutory law under which the corporation was formed? ii. State law often sets forth the acts that a corporation may legally perform. These acts should be in the aid of a proper corporate purpose. iii. If the corporation engages in an improper purpose or uses an improper power, that purpose or act is said to be ultra vires (beyond the corporations powers). iv. Powers of a Corporation a. A corporation has express power to perform any act authorized by the general corporation laws of the state & those acts authorized by the articles of incorporation. b. In most states, corporations also have implied power to do whatever is reasonably necessary for the purpose of promoting their express purposes and in aid of their express powers, unless such acts are expressly prohibited by common or statutory law. B. Corporate Social Responsibility i. Debate about the responsibility of corporations: a. A corporations objective should be to produce the best possible goods and services, that no other legal standard is enforceable, and that any other standard allows an unhealthy divorce between management (making decisions) and ownership; VS b. Corporations have a social responsibility and that they must balance the interests of stockholders, employees, customers, and the public at large. C. Charitable Contributions i. Charitable contributions tend reasonably to promote corporative objectives, and is a lawful exercise of implied corporate power. a. ***A.P. Smith Mfg. Co. v. Barlow, 346 U.S. 861 (1953) Corporation gave a gift of $1500 to Princeton University; the gift was challenged by a shareholder. Corporations president & other execs say the gift was an investment (qualified graduates would work for them), that it created a favorable environment for the company, and that the public had a reasonable expectation of such socially oriented contributions by the corporation. Its more like advertising; theyre furthering their corporate image. 1. A corporation may participate in the creation and maintenance of community, charitable, and philanthropic funds as the directors deem appropriate and will, in their judgment, contribute to the protection of corporate interests. 2. Del C. 122: Ever corp created under this chapter shall have the power to...(9) Make donation for public welfare or for charitable, scientific or educational purposes D. Business Judgment Rule i. A corporation is organized primarily for profit of the stockholders, and the powers of the directors are to be used for that end. However, directors have 29

reasonable discretion, to be exercised in good faith, to act for this end. Directors also have the power to declare dividends and their amounts. Their discretion will not be interfered with unless they are guilty of fraud, misappropriation or bad faith (when there are sufficient funds to do so w/o detriment to the business). a. ***Dodge v. Ford Motor Co., 204 Mich. 459 (1919) - Shareholders of Ford brought suit to prevent expansion of a new plant and to compel the director to pay addl special dividends. Corporation had surplus and Ford wanted to use it to increase production and cut prices of cars to benefit the public (reinvestment). 1. Here, Fords discretion to expand the business and cut car prices is upheld. Past experience shows Ford mgmt has been capable & acted for the benefit of its shareholders, & it doesnt look like any detriment to shareholders interests. Fords expansion plans can still be carried out & there would still be surplus available for dividends. So court says the surplus dividends after that should be distributed. ii. It is not the function of the courts to resolve a corporations questions of policy and management, and the judgment of directors will be accepted by the courts unless those decisions are shown to be tainted by fraud, illegality or a conflict of interest. a. Shlensky v. Wrigley, 95 Ill.App.2d 173 (1968) minority shareholder of corporation that owns Wrigley field & the Chicago Cubs brought a derivative suits against directors for refusing to install light on the field & to schedule night games for the Cubs as other teams had done to increase revenues. Motivation in refusing to do this was the view of the majority shareholders that it wanted to preserve the surrounding neighborhood & believed baseball was a daytime sport. 1. Business judgment rule presumption of good faith. No evidence that installing lights and scheduling night games will bring extra revenue, and theres a detrimental effect on the neighborhood (if it brings neighborhood down, fans may not want to see games in poor areas; property value might go down). No evidence that the motives of directors are contrary to the best interests of the corporation and stockholders. 2. Corporations are not obliged to follow the direction taken by other, similar corporations. Directors are elected for their own business capabilities and not for their abilities to follow others.

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THE LLC LLCS AND PIERCING THE VEILI. The Operating AgreementA. Although LLCs are governed by statute, LLC statutes generally provide that the members can adopt an operating agreement with provisions different from the LLC statute. Generally, the operating agreement will control. B. Operating Agreement controls if there is no conflict with mandatory statutory provisions.

II. Piercing the "LLC" VeilA. It is unlcear whether corporate principals of law, like piercing the veil, applies to LLCs. B. Uniform LLC Act 303(b) The failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company. C. Sometimes, though, the court will hold that the LLC veil may be pierced in a manner similar to piercing the corporate veil. i. Kaycee Land and Livestock v. Flahive, 46 P.3d 323 (2002) entered into a K with FOG, which allowed FOG to use s real property. alleges that during its use of the property, FOG caused environmental contamination of the property. FOG has no assets, and wants to pierce the veil to hold , FOGs managing member, liable. a. Every state that has enacted LLC piercing legislation has chosen to follow corporate law standards. There is no reason to treat LLCs differently than corporations. If members of an LLC fail to treat the LLC in the manner contemplated by statute, they should not be free from individual liability.

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DUTIES (OFFICERS, DIRECTORS AND OTHER INSIDERS)II. IntroductionA. Directors are normally held to have the duty of mgmt of the corporation. These duties are normally delegated to the officers; so, the directors must supervise the officers. The legal duties of the directos and officers are owed to the corporation, so the performance of these duties is usually enforced by an action on behalf of the corporation brought by an individual shareholder (derivative action). B. Fiduciary Relationship of directors to the corporation. Directors have fiduciary duty to corporation and the mgmt of its affairs, since they manage on behalf of shareholders. i. Duty of Loyalty. Directors are bound by the rules of fairness, loyalty, honesty and good faith in their relationship, dealings and mgmt of the corporation, as are officers. ii. Duty of reasonable care. Directors must exercise reasonable care, prudence, and diligence in the mgmt of the corporation. iii. Business Judgment. When a matter of business judgment is involved, the directos meet their responsibility of reasonable care and diligence if they exercise an honest, good-faith, unbia